Wednesday, September 22, 2010

Will the economy hit a sudden wall? And Flip and Dip, baby! Flip and Dip.

One of the tales of malarky you hear by those rationalizing that the economy is turning around, it that the US consumer is bearing down and paying down debt. This, the argument goes, augers well for the return of balance.

Well, not so fast.

As the Wall Street Journal notes, this isn't what is actually happening at all. The reality is that over the past two years, US consumers have not been deleveraging as a voluntary act of eliminating debt, but have been actually aggressively leveraging more and more until the bank providing them credit puts them into involuntary bankruptcy, cutting off the money flow.

This is a startling realization.

What it means is that the average American is actually hyperleveraging to the point where all available credit is forcefully eliminated by a lender institution in one fell swoop!

The data outlined by the WSJ confirms that of the over $600 billion in deleveraging that has occurred, only $20 billion or so of it was voluntary. Irresponsible borrowing practices, in which US consumers spend, spend, spend themselves into oblivion, accounts for the balance.

Consumers aren't changing their habits at all. They are continuing to binge only to be cut off cold turkey.

Consumers are accelerating spending until the charge off threshold at the lender is breached, and all credit is cut off, which results in a collapse of a creditor's FICO score, cutting him or her off completely from future (at least near term) credit access.

What this means for consumption is that we are building to an abrupt collapse of the consumer economy whereby a massive number of consumers will be saying goodbye to credit for a very long time.

With American unemployment still at record highs, and soon to take another leg higher, with paychecks continuing to decline, with excess capacity at record highs, with unemployment claims reaching their ceiling 2 year anniversary from the Lehman collapse, and with the general economy double dipping; the implications of this will be dire, as there will be no gradual decline.

Instead we are staring at a looming abrupt collapse.

The implications here for the economy, and the stock market, are profound.

Meanwhile in local real estate...

On the slow melt front, faithful reader, R.D., has been keeping tabs on 2699 Cambridge Street, MLS V850651 which is located just west of the PNE in Vancouver's eastside neighbourhood of Hastings/Sunrise.

Purchased in early September, 2009 for $838,000 the property was listed just last month (August, 2010) for $926,000. Presumably no additions, alterations nor upgrades were done to the property.

You've got to love optomism, don't you?

But rather than flip for a profit, it appears the buyer is headed to flip for a dip - a dip in equity.

The asking price was first reduced to $859,000 which means the buyer would be only breaking even after realtor fees, transfer fees and any lost/paid out interest - not to mention what could have been gained by investing elsewhere.

But that's not the end of this tale of woe. Now the asking price has been dropped to $826,000.

R.D. tells me he thinks $750,000 is reasonable level for this to drop to.

Seems even some Bears don't fully appreciate what's about to happen.

What about you? Are there any properties you have been watching that have been dropping their asking price? If yes, drop me an email and tell me about it.

Quite interesting. Regarding the home, the question to ask is, what can it go for? Lower than anyone believes is my position. People really want to believe that there is an intrinsic value near their price..reality is they can chase the market.

In the US midwest (the part with relatively strong employment), I saw a home very near me start at $889k brand new, regional developer started to market in 2005. Rode the 'melt' down, bit, by bit..eventually sold for $480k in 2009 still unlived in..so witness that, $400k 'gone' in for years. The seller, should be lucky to get out now. My belief is with a 50-70% collapse in Van by the time it's all said and done. Long term fundamentals matter, and the price to income ratio dictates a supportable reality. Therefore prices, must fall, substantially.

"What this means for consumption is that we are building to an abrupt collapse of the consumer economy whereby a massive number of consumers will be saying goodbye to credit for a very long time."

I completely agree. What I don't understand is how you can look at that and see anything but deflation in the near term (at least several years). How does this jive with the near-term hyperinflation position?

Hyperinflation is a distinctly different phenomenon from either of deflation or inflation.

Most people think hyperinflation is an extension or amplification of inflation.

It isn't.

Inflation and hyperinflation are two very distinct animals. They look the same because in both cases, the currency loses its purchasing power, but they are not the same.

Inflation is when the economy overheats: It’s when an economy’s consumables (labor and commodities) are so in-demand because of economic growth, coupled with an expansionist credit environment, that the consumables rise in price. This forces all goods and services to rise in price as well, so that producers can keep up with costs. It is essentially a demand-driven phenomena.

Hyperinflation is the loss of faith in the currency.

Prices rise in a hyperinflationary environment just like in an inflationary environment, but they rise not because people want more money for their labor or for commodities, but because people are trying to get out of the currency. It’s not that they want more money —they want less of the currency. So they will pay anything for a good which is not in the currency they have lost faith in.

I fully get all of that. So tell me again where this loss of faith will come from in the near term because so far you've perfectly illustrated deflationary forces at work, then conclude that we're near hyperinflation. I'm not seeing where you made that jump.

Like I've said before, you and I agree fully on the end result here, but the US will not be the first domino to fall. If there will be a sovereign default it will be out of Europe first. Where do you think the accompanying capital flight out of Europe will find a new home? Yup....US dollar. I agree it's erroneous thinking, but you know it will take some time for people to reverse their thinking of the USD as the safe reserve currency.

You will be right about hyperinflation, but not for several years in the US and not for at least half a decade here in Canada. At least!

This is Ben from financialinsight.wordpress.comby the way. Keep up the great work re: our real estate bubble here in Canada.

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History of Central Banks

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